The fiscal cliff and housing

The housing market has finally improved and it looks like the worst is behind us. However if the Washington dummies fail to resolve the fiscal cliff, housing is in trouble.

Fiscal cliff could cost the U.S. two million jobs next year and cause the unemployment rate to stay stubbornly stuck above 8% through 2014. Fewer jobs could translate into less demand for new homes, possibly even a new wave of foreclosure filings as newly unemployed workers struggle to make mortgage payments.

Uncertainty is always a problem and could cause Americans — particularly Americans with higher levels of discretionary income — to pull back on consumer spending, holding off on major purchases like homes. At least until a resolution is realized.

“While there are underlying forces pushing growth in housing, it’s not going to be robust until the public gets comfortable with the idea there is going to be a growing employment and income environment,” Doug Duncan, chief economist at Fannie Mae, told the Wall Street Journal recently.

“The stability of people’s jobs does impact their confidence to spend moving forward,” adds Mark Cole, executive vice president of CredAbility, an Atlanta, Ga.-based nonprofit that offers credit and housing counseling services. CredAbility’s Consumer Distress Index indicates that housing led households out of financial distress in the second quarter for the first time since 2008. Yet Cole says average American families have been cautious about taking on new debt (if they can even qualify), choosing rentals over home purchases, according to the organization’s data.

New home building will be hit hard if a recession is realized, too. “It will reverse the small gains we have made in home building thus far,” says David Crowe, chief economist of the National Association of Home Builders (NAHB).

If Congress drives the economy off the “fiscal cliff,” wave goodbye to short sales that have helped the housing market get back on its feet. At risk is a provision that erases taxes on selling a home for less than what’s owed to the bank.

Expiration of the tax treatment would create a major new headache for the one in four homeowners who owe more than their house is worth. Those “underwater” sellers would have to come up with a big check for Uncle Sam to pay the tax on the difference.

That “would be a blow to the housing recovery,” said Paul Diggle, a housing economist at Capital Economics. “The increased use of short sales, rather than foreclosures, has become an important support to the recovery.” Currently, roughly a quarter of all home sales are short sales. There are several reasons they’ve become much more common in the aftermath of the biggest housing bust since the 1930s.

The five biggest mortgage lenders also got an amazing gift in the way of an incentive to forgive more mortgage debt . Under a complex formula, the lenders earn credits against a portion of the settlement payment for each dollar of mortgage debt forgiven.

In addition, until the housing collapse, forgiven mortgage debt was taxed as ordinary income, but in 2007, Congress passed the Mortgage Debt Relief Act, which forgives debt from taxes. The law was extended in 2010 but is due to expire at the end of the year unless Congress acts to steer away from the so-called “fiscal cliff.”

Another consequence? Poor and elderly Americans who rely on aid from the federal government to heat their homes stand to get less help this year if Congress and the White House fail to figure out a way to avoid the combination of tax increases and automatic spending cuts known as the fiscal cliff.
Of course, a sacred cow of real estate, the home mortgage interest deduction is on the chopping block. If that goes away more people would be inclined to rent rather than buy. That’s great if you own rental homes but if you are in the fix and flip mode, it could be a problem.